7/27/2011
By Brian Sozzi, Research Analyst

Welcome back Dunkin Donuts (DNKN) to the public markets ladies and gentleman.  Perhaps I harness greater excitement on this topic since I grew up eating Baskin Robbins, made Dunkin coffee my first choice after being allowed to indulge on hot brewed caffeine, and come from the Northeast.  Still, even if a person is unfamiliar with the Dunkin Donuts moniker, rest assured that a return to being a publicly traded company will lead to a store being opened in neighborhoods all across the U.S. States.  That being said, and without being too wonkish, the IPO priced at the top end of its expected range at $19.00.  In other words, investor appetite was strong, and with good reason.  The company has an understandable business model that churns out industry leading operating margins.  Moreover, there is a clear runway to new unit and new product growth.

Investor List of Likes and Dislikes

Likes

Business model: A 100% franchised business that at the minimum, lends way to continued strong expansion of new units (only costs $474,000 to open up one) and indirect exposure to inflation (franchisee has the responsibility for supplies; higher coffee or milk costs may lead to price increases that hurt same-store sales growth, in turn hurting the performance of the parent company in the form of reduced franchisee revenues).  Business is recession resistant, not recession proof; financials will hold relatively well during a recession due to more affordable price points compared to peers.  Company is on K-Cup phenomenon.

Clear path to growth (important for IPO): Management has outlined a goal for 15,000 U.S. Dunkin Donut stores, up from about 6,799 currently.  Importantly, an investor could see it unfolding; the company only has 1.6% of its sales derived from Western U.S., with the core markets being New England and New York.  Fun fact: there is one Dunkin Donuts for every 9,700 people in New England and New York.

Foothold internationally: IPO is not solely being used as a function to bring the Dunkin Donuts and Baskin Robbins brands overseas, each brand name has exposure to international markets (South Korea, Japan; shortly India).
Superior operating margin: The company had a 1Q operating margin that was nearly double that of Tim Horton's (THI) and Starbucks (SBUX) in their latest quarters, indicative of a fine tuned franchise model (I watch these workers in the stores, everything is so process driven and down to a science; one could also feel the sense of purpose being that the stores are owned by a franchisee).

Dislikes

* Smaller store base internationally relative to Starbucks; Tim Horton's owns Canada.
* Brand is not a national brand yet.
* The aggressive store growth target may prove far-reaching given the company's debt load ($1.5 billion).
* Baskin Robbins is producing soft same-store sales growth, and the operating margin profile of the business is lower than the Dunkin Donuts brand.
* Increased competition in the grocery aisles.

Brian Sozzi
Wall Street Strategies

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